Econ exam 3 - Sarah Anderson Exam 3 What is meant by the...

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Sarah Anderson Exam 3 What is meant by the "velocity" of money? b) If velocity could be predicted accurately, why would that be useful to poliocymakers? the average frequency with which a unit of money is spent in a specific period of time. Velocity associates the amount of economic activity associated with a given money supply. When the period is understood, the velocity may be present as a pure number; otherwise it should be given as a pure number over time. In the equation of exchange, velocity of money is one of the variables claimed to determine inflation. If, for example, in a very small economy, a farmer and a mechanic, with just $50 between them, buy goods and services from each other in just three transactions over the course of a year Farmer spends $50 on tractor repair from mechanic. Mechanic buys $40 of corn from farmer. Mechanic spends $10 on barn cats from farmer then $100 changed hands in course of a year, even though there is only $50 in this little economy. That $100 level is possible because each dollar was spent an average of twice a year, which is to say that the velocity was 2 / yr . Explain the fundamental differences between debt instruments (e.g. bonds) and equities such as common stock in? Debt = the debtor is required to repay you the money you invested, often with interest. A debt instrument is a debt obligation. Picture you (the bank) agreeing to give the company (the bank's customer) a loan to help the company expand its business. The risk of default is dependent on many factors, but you can sue the company if they default on the loan. Generally, the risk is lower than buying equity in the company. Therefore, the expected return is lower than equities. Equity = you are a partial owner of the business. You are not lending the company money. You are buying a piece of the company. Picture you owning a few bricks in the building at their main office. The company is not obligated to pay you anything. They may give you a small amount if they think it is in their best interest to do so (called a dividend). With equities, there is no obligation on the part of the company to pay you anything. Holding a company's equity is higher risk than holding the company's debt. Therefore, the expected return is higher than that of debt instruments. Why would you expect an increase in the reserves of the banking system to cause bank deposits to increase by a greater amount?
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Banks must maintain a percentage of their deposits as a reserve, so if deposits increase reserves will also increase. The higher the reserves the safer the bank attracting more deposits. How can banks promise to pay depositers on demand when most of the money they receive from
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Econ exam 3 - Sarah Anderson Exam 3 What is meant by the...

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